Ask Louis: Are We Headed For Another Downturn?

In a recent meeting with my Family Trust readers, I received an excellent question:

Q: How likely is another downturn like we saw in 2007/2008?

This question hits at the heart of how investors I have spoken are feeling about the market right now. So let’s take a moment to address this trillion dollar-question.

There’s a very specific reason why many are asking this question. You may have heard that another newsletter analyst—Marc Faber—is predicting that 2013 is going to be a repeat of 1987[1]. His argument is that we’re on the same track as that year because we’ve had a poor earnings season. Because the market is going up in a poor earnings environment, we’re headed towards a 20% correction. That’s what he says.

But here’s what I say: If you analyze the correlations, the market is closer to 1995 than it is to 1987[2]. What this year has in common with 1995 is the sudden spike in bond yields. When bond yields go higher, fixed-income investors become nervous that they’re losing money and high-dividend stocks get more volatile. I’ve been monitoring these trends carefully.

What’s happening is that many fixed-income investors are now trying high-dividend stocks and blue chip stocks. They’re tip-toeing into the market, leading to record inflow of funds. So I think 2013 is going to be more like 1995—in that year we barely had a 5% correction. I like the trends I’m seeing in the market. Every time the market pulls back we see a rebound in institutional buying pressure. So I think we’re in a very healthy environment.

The reason that Mr. Faber is perpetually bearish is that fear always sells better than greed. This is the time of year where the bears come out because much of Wall Street and the European stock exchanges are on vacation. Short sellers see this as an opportunity to come in and jerk the market around.

But frankly, because the market still yields more than the bank—2%, and tax advantaged at that—I think that a lot of money will continue to meander into the market. I don’t think there is a substantial risk of a severe correction in the market.

Endnotes:

2013 is going to be a repeat of 1987: http://www.cnbc.com/id/100950234

the market is closer to 1995 than it is to 1987: http://navelliergrowth.investorplace.com/blog/archive/2013/06/2013-1995-comparison-investinglessons.html